Abstract

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Few doubt that executive compensation arrangements encouraged the excessive risk taking by banks that led to the recent Financial Crisis. Accordingly, academics and lawmakers have called for the reform of banker pay practices. In this Article, we argue that regulator pay is to blame as well, and that fixing it may be easier and more effective than reforming banker pay. Regulatory failures during the Financial Crisis resulted at least in part from a lack of sufficient incentives for examiners to act aggressively to prevent excessive risk. Bank regulators are rarely paid for performance, and in atypical cases involving performance bonus programs, the bonuses have been allocated in highly inefficient ways. We propose that regulators, specifically bank examiners, be compensated with a debt-heavy mix of phantom bank equity and debt, as well as a separate bonus linked to the timing of the decision to shut down a bank. Our pay-for-performance approach for regulators would help reduce the incidence of future regulatory failures.

Date posted: August 28, 2011
; Last revised: September 12, 2011

Suggested Citation

Tung, Frederick and Henderson, M. Todd, Pay for Regulator Performance (August 24, 2011). U of Chicago Law & Economics, Olin Working Paper No. 574; Boston Univ. School of Law, Law and Economics Research Paper No. 11-43; Boston Univ. School of Law, Public Law Research Paper No. 11-43. Available at SSRN: http://ssrn.com/abstract=1916310 or http://dx.doi.org/10.2139/ssrn.1916310